Inflation check

| Updated on April 20, 2021

The Centre needs to pull its weight to keep inflation in check along with the RBI

The Monetary Policy Committee decided to give precedence to growth over inflation in the recent meeting and it is not difficult to see why. Given the nebulous state of the economy and movement restrictions in large metros threatening to derail growth in FY22, it had to do all it could to ensure that growth is not affected. But the committee may not be able to keep ignoring inflation for long, given the pace at which it is increasing and the debilitating impact it has on household savings and consumption. Given the tough challenge before the RBI in managing liquidity and supporting the government borrowing, it may not be able to do the job all by itself. A close look at the drivers of inflation shows that the Centre needs to work with the RBI to check prices.

While headline CPI inflation increased to 5.5 per cent in March, WPI inflation was also at multi-year high, at 7.39 per cent. The increase was largely led by higher food and fuel prices. In the food basket, higher global prices have had an impact on pulses and oil and fat, increasing food inflation. While a normal monsoon can help to some extent, the Centre should stay vigilant to check supply disruptions due to lockdowns in the weeks ahead. The process of issuing passes for inter-state transport should be smoothened and steps should be taken to pick agri-produce from farm gates, to avoid wastage due to movement restrictions. The government can again play a role in bringing down fuel prices. While the increase in prices of petroleum products was partly due to the 50 per cent increase in the Indian basket of crude oil between September 2020 and this February, the failure to reverse the tax hikes on petroleum products made during the lockdown last year is also a cause for inflating fuel prices. As the RBI pointed out, total share of central excise and states’ value added tax in petrol prices has risen from ₹22 per litre in mid-2014 to ₹53 per litre in February 2021. Both the Centre and the States can roll back the taxes levied last year to provide some relief.

With credit growth still very tepid at 5.2 per cent, increasing policy rates will not help in cooling inflation. The RBI is facing a tricky situation as the excess liquidity due to the open market operations and foreign exchange interventions is adding to the inflationary pressure. The central bank has rightly shifted its forex interventions to the forward market but it will have a tough job in maintaining liquidity at the optimal level given that it has also promised to buy G-Secs in the secondary market through the G-SAP programme. With the second wave of Covid likely to expand the government’s fiscal deficit for FY22, government borrowing may increase further. While the central bank will have to use all the tools at its disposal, the Centre also needs to lend a hand to keep inflation in control.

Published on April 20, 2021

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